The day-one impact of the cap on dark trading using the Negotiated Trade Waiver
(NTW) and the Reference Price
Waiver (RPW) will hit large and
midcap stocks hard. The rules will
mean that smart order routers
looking for non-lit liquidity will find
most familiar routes boarded up.

“We suspect that large numbersof index names across Europe willbe capped,” says Rob Boardman,managing director and chief exec-utive officer for Europe at agencybroker ITG. “I am talking many,many hundreds of names. We alsothink in the UK, where dark trad-ing is at its most prevalent, that willrun right through to the mid-capsand the FTSE 250 as well, whichwill be particularly problematic.”Trading on lit markets and onmarkets using the large-in-scale(LIS) waiver will not be affected,but the exact level of trading ofnon-LIS that occurs in the dark isopen to market analysis. While re-search into dark trading by marketstructure specialist broker Rosen-blatt estimates that dark trading inEurope has hit around 8%, MichaelHoran, head of trading at Pershing,says that the proportion of darktrading in stocks can be up to 20%in some cases.

“I would say for around half of the
stocks in the FTSE 100, dark liquidity trading using the NTW and the
RPW is around 15-20%,” he says.

The caps for trading are applied
to the NTW and RPW, with a 4%

cap on their use applied to a specific venue and an 8%
cap applied to the entire European market for a given
stock. Officially they will be applied, mid-week, from
Wednesday 3 January 2018.

“It’s based on a rolling stock 12 month average, sothey started the count from January this year - whichmany people do not realise, thinking it starts from Jan-uary 2018 - so they have already been working out theaverage usage of the reference price waiver and thenegotiated waiver,” explains Horan. “What we thinkwill happen is that dark pools using those two waiverswill be banned on day one.”Richard Semark, managing director for equities atUBS and CEO of UBS MTF, says that the exact pointat which the rolling stock data will be published is notcertain, and that the caps may only come into effect aslate as mid-January.

“We think they may not publish that data until
sometime in the week beginning 8th January,” he says.

“The market has not had much of a chance to respond
to this and once that first six month suspension is
complete you may see venues voluntarily turning
stocks off.”

Execution impacted

The routing of orders and measurement of execution quality will be challenged by the shift in market
structure, which will see liquidity migrate from broker
crossing networks to lit and LIS venues, as both smart
order routers (SORs) and transaction cost analysis
(TCA) use historical data sets to help quantify best
execution opportunities and assessment.

“Historical data will be of less validity that people
have been used to for the last 10 years or more,” notes
Semark.

As a result, new data sets will have to be built up
in order to assess execution against the new market
structure, with sell-side firms reassessing the liquidity
picture.

“Most brokers, when they assemble historic volumeprofiles for venues or trading over the day tend tolook at 3-4 weeks,” says Boardman. “When lookingback more than that you are seeing different marketconditions, and if you look back less than that you arelooking at a smaller data set. So the first month will bethe greatest challenge [for execution].”That does not mean trading will become settled afterthe first month however. The fluidity of stocks movingin and out of suspension for waivers will change andtrading will be affected as a result.